Private wealth management advisory firms, established as family offices, provide financial and advisory services for members of their inner circle. As they have historically been generally established without Securities and Exchange Commission (SEC) nor Commodity Futures Trading Commission (CFTC) registration and oversight, insurance carriers have been cautious about assuming the liability risks of these entities.
However, Congress’ House Financial Services Committee has taken steps toward implementing tighter regulations with the introduction of H.R.4620 - The Family Office Regulation Act of 2021. This proposed legislation would require, among other stipulations, that family offices with more than $750M in Assets Under Management (AUM) to register with the SEC. It would significantly scale back previous exceptions made for family offices under the Investment Advisor Act of 1940 and section 409 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. While the bill is still navigating through the legislative process, private fund managers should be prepared to operate in a more regulated environment, which could, in turn, change the perspectives of management liability underwriters moving forward.
The SEC has been increasing its scrutiny of private fund managers since financial institutions invested in toxic real estate securities, the major contributor to the 2008 financial crisis. From the vantage point of a non-sophisticated investor, given the lack of regulatory oversight and disclosure requirements, family offices are viewed as volatile.
The recent implosion of Archegos Capital Management, which collapsed because outside investment agreements in speculative assets were a large percentage of its total portfolio, along with the firm hiding its exposure from banks, exemplifies the volatile nature of private fund organizations left without critical oversight. Proper regulation would perhaps have provided legal disclosures preventing the Archegos financial mishandlings. Without federal monitoring, insurance carriers are fearful that family offices will continue to engage in high-risk, and possibly fraudulent, activities.
Family offices are also considered volatile because of the prospect of family members disagreeing over the management of assets, especially when money is pooled into the same funds.
While family offices are currently exempt from registering with the SEC as investment advisors, the government is pushing to remove the exemption and bring regulatory scrutiny over family offices and private fund operators under the purview of the SEC.
Private fund managers are vehemently opposed, calling the additional regulations an imposition of increased costs and unnecessary policing, and holding that family offices were intended to always be exempt from registration requirements.
While there is new capacity and a softer market than 2021 in the management liability space, carriers have yet to increase underwriting appetite for family offices. However, there are more existing carriers wanting to expand their underwriting appetite and product offerings which private fund managers can leverage.
The tallest hurdle with family offices for underwriters is the absence of disclosure. As family offices do not have to file a Form ADV, which discloses the organization’s business operations, investment strategies, and relationships, they can remain fully private – a lack of transparency which underwriters find enigmatic.
The more transparent a family office is, the more attractive it becomes to a carrier. Providing visibility ensures a family office is not performing ancillary services that could expose the office and the insurance carrier to claims for mismanagement of investments or faulty tax preparation and accounting.
Documenting and providing the following information will prepare a family office for a heightened regulatory environment and give more comfort to the underwriting community:
More thorough oversight will help management liability insurers feel more comfortable writing policies for family offices. The insurance market's reaction hinges on how family offices adapt to new regulations that will reshape the landscape they have traditionally been operating in.
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